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WhatsApp Acquisition, Intangible Assets and Sky-High Valuation

The WhatsApp acquisition is worthy of inclusion in the Guinness Book of Records: Facebook will pay a staggering 19 billion. How can we make sense of such a massive pricetag? This is for sure something that Facebook executives will need to shortly explain to their shareholders. But in the current environment where intangible assets drive value, explaining a price-tag is more difficult than one might think.

While a company’s brand recognition, the patents, copyrights and trademarks they own and the business methodologies they employ don’t have obvious physical value, these intangible assets nonetheless contribute to a company’s overall value. In fact, researchers have shown that value drivers are increasingly shifting from tangible to intangible resources. That said, unlike tangible assets whose value can be easily measured and disclosed through financial statements, companies are not required to disclose information about their intangible assets.

Facebook now has 12 months to complete the purchase price allocation, that is to say, allocate $ 19 billion to acquire the asset. Once this process is completed, Facebook will decide on the amount of information to present to investors in its financial statements.

Intangible assets clearly explain much of the agreed price for WhatsApp. The company has some interesting technology for Facebook, which is looking to expand its mobile business. In addition, the WhatsApp brand is strong and is attracting users, especially in Europe and in emerging markets where Facebook is looking to expand its presence. Therefore, information on the nature and value of the acquired intangible assets will certainly be expected by investors wanting to know if Whatsapp was really worth $ 19 billion.

But what are the risks for acquiring companies like Facebook? If the value of a company depends largely on these intangible assets, should we not require companies to disclose more information about them? New Research by Pierre Astolfi (Université Paris-Est Créteil), Anne Jeny-Cazavan (ESSEC) and Luc Paugam (ESSEC) weighs in on this important issue for standard setters and investors.

“In the mandatory disclosure vs. status quo debate, both camps raise convincing arguments,” says Professor Anne Jeny-Cazavan. “Although financial statements fail to recognize key intangible resources, it can also be argues that intangibles generate wealth for companies in the long-run and so eventually show up these statements. That said, our new research – Should Additional Disclosure be Mandated for Intangible Assets? Insights from Purchase Price Allocations – provides an empirical setting to test both arguments and help fill the existing knowledge gap. Ultimately, it makes an interesting case for additional disclosures.”

When important intangible information falls by the wayside

In particular, firm acquisitions – when one business buys another – are events where intangible assets like brand recognition, technologies, patents, customer relationships are critical. The acquirer may purchase the target firm only to control those intangibles resources. In these situations, the acquiring company must recognize all the intangible assets of the acquired company either as separately identified assets or as goodwill. With weak enforcement of mandatory disclosure, as is the case today, this information differs from company to company.

“In this research, the different treatment of newly acquired intangible assets let us test the potential consequences of specific disclosures,” explains Luc Paugam. “What we found was that when companies do not provide details of the acquired set of intangibles, returns were abnormal as investors were unable to accurately assess value.”

“Take for example the striking example of E-Bay’s acquisition of Skype in 2005. If E-bay had been aware that Skype didn’t own many of its programming patents, this would have been a deal-breaker. The information was not shared because this type of disclosure wasn’t mandated.” “Moreover, this acquisition ends with the recognition of a goodwill of 2,300 MUSD for an acquisition price of 2,600 MUSD”, underlines Anne Jeny-Cazavan.

Finally, this study provides a first attempt to empirically address the critical problem of accounting for intangible assets. This problem is central for companies such as Facebook seeking to justify a purchase from their shareholders or to avoid unpleasant surprises.

All-in-all, this research presents an initial attempt to empirically address the critical issue of accounting for intangibles. Paving the way for future investigation into information asymmetries, the paper was recognized with an Honorable Mention at the 9th interdisciplinary workshop on Intangibles, Intellectual Capital and Extra-Financial Information in Copenhagen, Denmark.